CTS Corporation (CTS) — Q3 2021 Form 10-Q
Business context and reporting period
CTS designs and manufactures sensing, motion and connectivity products for transportation, industrial, medical, aerospace and defense, and telecom and IT markets. This unaudited report covers the three and nine months ended September 30, 2021; comparisons are with the same 2020 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $122.4 | $113.8 | $380.4 | $301.0 |
| Gross margin | $45.7 (37.3%) | $36.9 (32.4%) | $135.9 (35.7%) | $96.4 (32.0%) |
| Operating earnings | $19.0 (15.5%) | $13.3 (11.7%) | $58.0 (15.3%) | $28.0 (9.3%) |
| Net earnings (loss) | $(63.9) | $11.1 | $(51.0) | $19.7 |
| Diluted earnings (loss) per share | $(1.97) | $0.34 | $(1.58) | $0.61 |
- Sales and market mix: Q3 sales rose 7.6%; transportation sales fell 4.5%, while sales to other markets increased 23.8%. For the first nine months, sales rose 26.4%, with transportation up 27.2% and other markets up 25.4%. SSI, acquired in December 2020, contributed $1.8 million of Q3 sales and $5.2 million year to date. Currency movements added $1.3 million and $6.5 million, respectively.
- Cash flow: Nine-month operating cash flow was $60.1 million, versus $49.3 million in 2020. Investing cash outflow was $8.4 million, including $8.1 million of capital expenditures; financing cash outflow was $15.4 million. Cash increased by $36.8 million to $128.5 million.
- Liquidity and debt: Current assets were $277.4 million and current liabilities $105.1 million at September 30. Long-term debt was $50.0 million, down from $54.6 million at year-end 2020. The $300 million revolving facility had $248.3 million available, subject to covenant restrictions; CTS reported compliance with all debt covenants. Cash less debt was approximately $78.5 million.
- Capital returns: Dividends declared were $0.04 per share in Q3 and $0.12 per share for the first nine months. CTS repurchased 148,035 shares for $4.9 million year to date; $45.1 million remained under the $50 million authorization.
Material changes and unusual items
- Operating performance improved year over year: gross margin and operating margin rose in both the quarter and nine-month period, with management attributing the improvement primarily to sales volume and mix. The 2020 comparison was affected by COVID-19, particularly in Q2.
- Despite higher operating earnings, CTS recorded a large net loss because of pension-plan settlement charges in other expense. The Q3 settlement charge was $106.2 million; total settlement charges were $126.3 million for the first nine months. The charges principally reclassified previously recognized pension losses from accumulated other comprehensive loss and were non-cash.
- The U.S. pension plan transferred obligations for approximately 2,700 participants to an insurer through a group annuity contract, funded from plan assets. Approximately $50.6 million of plan assets remained pending completion of administrative steps, expected in Q1 2022, after which assets are expected to revert to CTS and be subject to income and excise taxes. CTS was still evaluating tax optimization and use of the surplus cash.
- The nine-month income tax benefit was $24.6 million; the effective tax rate was 32.5%, versus 24.4% in 2020. The filing attributes the increase primarily to the pension settlement charges and the mix of earnings by jurisdiction.
Outlook, risks and contingencies
- CTS provided no specific quantified financial guidance in this filing. Management expects supply-chain challenges to continue to affect results in 2021 and into 2022 and remains cautious about their financial impact.
- COVID-19-related disruption, semiconductor and resin shortages, OEM production shutdowns and short-notice order changes have increased material and freight costs and may leave CTS with excess inventory. Management said transportation markets were particularly exposed.
- Other stated risks include competition, technology changes, customer dependence, acquisition integration, foreign exchange and international risks, and environmental compliance and remediation. Cummins represented 14.3% of Q3 sales and Toyota 10.0%; together they accounted for 27.1% of nine-month sales.
- CTS had $9.994 million in environmental remediation reserves and disclosed environmental matters at several current or former sites, including two Superfund sites. Other ordinary-course legal claims are pending. The company cautioned that ultimate environmental, legal or warranty liabilities could exceed accruals and adversely affect results or cash flows.
- The company plans to modify its LIBOR-indexed credit agreement and related hedges before June 30, 2022, as part of the transition to an alternative reference rate. Management stated that cash from operations and available credit should fund needs for at least the next 12 months.
Key facts for investors to verify
- Underlying operating earnings and margins excluding the unusual pension settlement charges, and the non-cash nature and accounting treatment of those charges.
- Timing, amount and tax consequences of the expected pension-plan asset reversion in Q1 2022.
- Duration and financial effects of semiconductor, resin, freight and other supply constraints, including transportation OEM shutdowns and inventory exposure.
- Customer concentration and the sales outlook for Cummins, Toyota and the transportation market.
- Potential changes to environmental remediation and other legal or warranty liabilities, as well as continued compliance with credit-facility covenants.